Rev. Rul. 60-232

Advice has been requested whether a distribution of certain property by a corporation to its shareholders in redemption of a portion of its stock qualifies as a distribution in partial liquidation of the corporation within the meaning of section 346(a) of the Internal Revenue Code of 1954.

The instant corporation was engaged principally in the business of repairing contractors' equipment. The corporation also bought, sold and traded used contractors' equipment. It had an inventory of such equipment which it rented to contractors. The corporation owns the building in which the business was conducted.

The above-described business was actively conducted until the date of its recent sale in an arm's-length transaction, the buyer having no business connection with the corporation and its stockholders. The assets sold consisted of rental equipment, all miscellaneous inventory, all work in process and a service truck. The buyer leased the real estate of the corporation and also other property, consisting of shop equipment, machines, tools, office furniture and fixtures and storage equipment. The corporation thereafter was engaged only in the business of leasing such property to the buyer.

The termination of the foregoing business made advisable the partial liquidation of the corporation. Accordingly, pursuant to a plan of partial liquidation, the corporation distributed an amount in cash and securities equal to the net proceeds from the sale of the business assets plus that portion of the working capital (cash, accounts receivable, etc.) attributable to the business activity terminated by the sale. This distribution was pro rata to the stockholders and each stockholder turned in for cancellation and redemption a portion of his stock in the corporation.

The issue is whether the amount of the distribution which is treated as in partial liquidation within the purview of section 346(a) of the Code may exceed the net proceeds realized from the sale of the business assets.

Revenue Ruling 55-373, C.B. 1955-1, 363, holds that where there is a genuine contraction of the corporate business activity, a distribution by a corporation in redemption of a portion of its capital stock is treated as in partial liquidation to the extent that the distribution does not exceed the net proceeds derived by the corporation from the bulk sales of its inventories, but that any excess distribution is taxable as a dividend under sections 115(a) and (g) of the Internal Revenue Code of 1939.

Section 346(a)(2) of the 1954 Code states, in part, that a distribution shall be treated as in partial liquidation of a corporation if the distribution is not essentially equivalent to a dividend, is in redemption of a part of the stock of the corporation pursuant to a plan, and occurs within the taxable year in which the plan is adopted or within the succeeding taxable year.

Section 346(b) of the 1954 Code states, in part, that a distribution shall be treated as a distribution within the meaning of the general rule of subsection (a)(2), if it is `* * * attributable to the corporation's ceasing to conduct, or consists of the assets of, a trade or business which has been actively conducted throughout the 5-year period immediately before the distribution * * *.'

It does not appear that prior case law, as developed under the 1939 Code, prohibited the distribution of working capital in addition to the proceeds of the sale of assets in situations where there was a genuine contraction of corporate activity.

The amount of working capital utilized in the operation of a terminated business would clearly be `attributable to' that business, as it was necessary to the conduct of the terminated business. Since section 346(b) of the Code merely defines one type of distribution which is included in the general rule set forth in section 346(a), the same result obtains under the general rule and, therefore, the amount distributable in partial liquidation may include that portion of the working capital which is reasonably attributable to the business activity terminated.

In view of the foregoing, the Service holds that, in general, the amount which may be properly distributed as a partial liquidation includes not only the net proceeds derived from the sale of operating assets, or the assets themselves, but also includes that portion of the working capital (including cash) reasonably attributable to the business activity terminated.

In determining the amount of working capital reasonably attributable to the operation of the business activity terminated, the Service will take into consideration all pertinent factors. The amount of working capital actually used in the business activity just prior to its termination will be the primary consideration. However, an unusual or abnormal increase just prior to the distribution in the size of inventories, work in process, accounts receivable, cash accounts, or other items, may indicate an attempt to secure partial liquidation treatment of a distribution involving an amount of working capital in excess of that normally required in the operation of the business terminated. The amount of cash and other liquid assets is never in itself an indication of the amount of working capital attributable to a business activity since a corporation may retain liquid assets in excess of the needs of its business. Because the determination of the amount of working capital attributable to any business activity is a factual matter, a specific determination on this point will be made by the Service only after an examination of the income tax return of the corporation making the distribution in partial liquidation.

Under the facts set forth in the instant case, it is held that the distribution by the corporation, limited in amount to the net proceeds from the sales of assets related to the contractor's equipment business plus that portion of the working capital reasonably attributable to the terminated business activity and no longer required in the operation of the continuing business activities, constitutes a partial liquidation within the meaning of section 346(a) of the Code.

Revenue Ruling 55-373, supra , is modified to the extent it holds that, in the situation there concerned, any excess of the amount distributed over the net proceeds from the bulk sale of inventories, regardless of the portion of the working capital reasonably attributable to the terminated business activities, was taxable as a dividend under section 115(a) and (g) of the 1939 Code.